Zheng Liu

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Zheng Liu

Vice President, International Research, and Director, Center for Pacific Basin Studies

Macro, Money, Chinese Economy

zheng.liu (at) sf.frb.org

Profiles: Google Scholar | LinkedIn | Personal website

Working Papers
Reshoring, Automation, and Labor Markets Under Trade Uncertainty

2024-16 | with Firooz and Leduc | May 2024


We study the implications of trade uncertainty for reshoring, automation, and U.S. labor markets. Rising trade uncertainty creates incentive for firms to reduce exposures to foreign suppliers by moving production and distribution processes to domestic producers. However, we argue that reshoring does not necessarily bring jobs back to the home country or boost domestic wages, especially when firms have access to labor-substituting technologies such as automation. Automation improves labor productivity and facilitates reshoring, but it can also displace jobs. Furthermore, automation poses a threat that weakens the bargaining power of low-skilled workers in wage negotiations, depressing their wages and raising the skill premium and wage inequality. The model predictions are in line with industry-level empirical evidence.

Targeted Reserve Requirements for Macroeconomic Stabilization

2023-13 | with Spiegel and Zhang | November 2023


We study the effectiveness of targeted reserve requirements (RR) as a policy tool for macroeconomic stabilization. Targeted RR adjustments were implemented in China during both the 2008-09 global financial crisis and the recent COVID-19 pandemic. We develop a model in which firms with idiosyncratic productivity can borrow from two types of banks—local and national—to finance working capital. National banks provide better liquidity services, while local banks have superior monitoring technologies. Switching lenders incurs a fixed cost, such that firms switch lenders only under sufficiently large shocks. Reducing RR on local banks boosts leverage and aggregate output, whereas reducing RR on national banks has an ambiguous output effect. Following a large recessionary shock, a targeted RR policy reducing relative local bank RR can stabilize macroeconomic fluctuations. However, the policy also boosts local bank leverage, raising default risks and liquidation losses. Our model’s mechanism is supported by bank-level empirical evidence.

Fiscal Stimulus Under Average Inflation Targeting

2022-22 | with Miao and Su | April 2023


The stimulus effects of expansionary fiscal policy under average inflation targeting (AIT) depends on both monetary and fiscal policy regimes. AIT features an inflation makeup under the monetary regime, but not under the fiscal regime. In normal times, AIT amplifies the short-run fiscal multipliers under both regimes while mitigating the cumulative multipliers. due to intertemporal substitution. In a zero-lower bound (ZLB) period, AIT reduces fiscal multipliers under a monetary regime by shortening the duration of the ZLB through expected inflation makeup. Under the fiscal regime, AIT has a nonlinear effect on fiscal multipliers because of the absence of inflation makeup and the presence of a nominal wealth effect.

Automation and the Rise of Superstar Firms

2022-05 | with Firooz and Wang | November 2023


Using an instrumental variable approach, we document evidence that the rise in automation technology contributed to the rise of superstar firms. We explain this empirical link in a general equilibrium framework with heterogeneous firms and variable markups. Firms can operate a labor-only technology or, by paying a per-period fixed cost, an automation technology that uses both workers and robots. Given the fixed cost, larger and more productive firms are more likely to automate. Automation boosts labor productivity, enabling those large automating firms to expand further, and thus raising industry concentration. Our calibrated model can replicate the highly skewed automation usage toward superstar firms observed in the Census data. Since robots can substitute for workers, increased automation raises sales concentration more than employment concentration, consistent with empirical evidence. In the model, automation raises aggregate productivity but exacerbates markup distortions. Our calibration suggests that a modest subsidy for automating firms improves welfare.

Turbulent Business Cycles

2021-22 | with Dong and Wang | November 2023


Firm-level evidence suggests that turbulence that reshuffles firms’ productivity rankings rises sharply in recessions. An increase in turbulence reallocates labor and capital from high- to low-productivity firms, reducing aggregate TFP and the stock market value of firms. A real business cycle model with heterogeneous firms and financial frictions can generate the observed macroeconomic and reallocation effects of turbulence. In the model, increased turbulence makes high-productivity firms less likely to remain productive, reducing their expected equity values and tightening their borrowing constraints relative to low-productivity firms. This leads to a reallocation that reduces aggregate TFP. Unlike uncertainty, turbulence changes both the conditional mean and the conditional variance of the firm productivity distribution, enabling a turbulence shock to generate a recession with synchronized declines in aggregate activities.


wp2021-22_appendix.pdf – Supplemental Appendix

Bank Risk-Taking, Credit Allocation, and Monetary Policy Transmission: Evidence from China

2020-27 | with X. Li, Peng, and Xu | July 2023


We study the impact of China’s 2013 implementation of Basel III on bank risk-taking and its responses to monetary policy shocks using confidential loan-level data from a large Chinese bank. Guided by theory, we use a difference-in-differences (DiD) identification, exploiting cross-sectional differences in lending behaviors between high-risk and low-risk bank branches before and after the new regulations. We identify a novel risk-weighting channel through which changes in regulations significantly reduced bank risk-taking, both on average and conditional on monetary policy easing. However, bank branches reduce risk-taking by increasing lending to ostensibly low-risk state-owned enterprises (SOEs) under government guarantees, despite their low average productivity. Our findings suggest that, under prevailing policies that favor SOEs, China’s monetary policy faces a tradeoff between bank risk-taking and credit misallocation.

Can Pandemic-Induced Job Uncertainty Stimulate Automation?

2020-19 | with Leduc | May 2020


The COVID-19 pandemic has raised concerns about the future of work. The pandemic may become recurrent, necessitating repeated adoptions of social distancing measures (voluntary or mandatory), creating substantial uncertainty about worker productivity. But robots are not susceptible to the virus. Thus, pandemic-induced job uncertainty may boost the incentive for automation. However, elevated uncertainty also reduces aggregate demand and reduces the value of new investment in automation. We assess the importance of automation in driving business cycle dynamics following an increase in job uncertainty in a quantitative New Keynesian DSGE framework. We find that, all else being equal, job uncertainty does stimulate automation, and increased automation helps mitigate the negative impact of uncertainty on aggregate demand.

Published Articles (Refereed Journals and Volumes)
Automation, Bargaining Power, and Labor Market Fluctuations

Forthcoming in American Economic Journal: Macroeconomics | with Leduc


We argue that the threat of automation weakens workers’ bargaining power in wage negotiations, dampening wage adjustments and amplifying unemployment fluctuations. We make this argument based on a business cycle model with labor market search frictions, generalized to incorporate automation decisions. In the model, procyclical automation threats create endogenous real wage rigidity that amplifies labor market fluctuations. The automation mechanism is consistent with empirical evidence. It is also quantitatively important for explaining the large volatilities of unemployment and vacancies relative to that of real wages, a puzzling observation through the lens of standard business cycle models.

Capital Flows and Income Inequality

Journal of International Economics 144 (103776), 2023 | with Spiegel and Zhang


We document empirical evidence that surges in capital inflows (outflows) raise (reduce) income inequality. We study the mechanism through which changes in capital flows and capital account policies can influence income distributions in a small open economy model. Our model features heterogeneous agents and financial frictions, with banks intermediating between household savings and entrepreneur investment. Inflow surges disproportionately raise entrepreneur income, exacerbating inequality, while increases in outflows boost the share of household income, alleviating inequality. Under capital-skill complementarity, capital account liberalization that induces net capital inflows raises both the skill wage premium and overall income inequality. These predictions are in line with our empirical evidence.
Please see August 2023 Erratum in supplemental files below.


n8crkjjy99 – Replication files
wp2020-14-erratum.pdf – Erratum: August 2023

A Theory of Housing Demand Shocks

Journal of Economic Theory 203 (105484), 2022 | with Dong, Wang, and Zha


Housing demand shocks in standard macroeconomic models are a primary source of house price fluctuations, but those models have difficulties in generating the observed large volatility of house prices relative to rents. We provide a microeconomic foundation for the reduced-form housing demand shocks with a tractable heterogenous-agent framework. In our model with heterogeneous beliefs, an expansion of credit supply raises housing demand of optimistic buyers and boosts house prices without affecting rents. A credit supply shock also leads to a positive correlation between house trading volumes and house prices. The theoretical mechanism and model predictions are supported by empirical evidence, and the results are robust to alternative specifications of heterogeneity.

Monetary Policy under Global Uncertainty: 2019 Asia Economic Policy Conference Summary

Journal of International Money and Finance 114, June 2021, 1-2 | with Spiegel

Interest-Rate Liberalization and Capital Misallocations

American Economic Journal: Macroeconomics 13(2), April 2021, 373-419 | with Wang and Xu


We study the consequences of interest-rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China’s distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, interest-rate liberalization can improve capital allocations within each sector, but can also exacerbate misallocations across sectors. Under calibrated parameters, the liberalization policy can reduce aggregate productivity and welfare unless other policy reforms are also implemented to alleviate SOEs’ distorted incentives or improve private firms’ credit access.


LWX_online_appendix.pdf – Supplemental appendix
LWX-code.zip – Supplemental data code
LWX-data_part1.zip – Data part 1
LWX-data_part2.zip – Data part 2
LWX-data_part3.zip – Data part 3

Optimal Capital Account Liberalization in China

Journal of Monetary Economics 117, January 2021, 1041-1061 | with Spiegel and Zhang


China maintains tight controls over its capital account. Its current policy regime also features financial repression, under which banks are required to extend funds to state-owned enterprises (SOEs) at favorable terms, despite their lower average productivity than private firms. We incorporate these features into a general equilibrium model. Our model illustrates a tradeoff between aggregate productivity and inter-temporal allocative efficiency from capital account liberalization under financial repression. As a result, along a transition path with a declining SOE share, welfare-maximizing policy calls for rapid removal of financial repression, but gradual liberalization of the capital account.


wp2018-10_appendix.pdf – Supplemental appendix
LSZ_ReplicationCode.zip – Replication code

Capital Regulations, Bank Risk-Taking, and Monetary Policy in China

VoxChina, 2020 | with X. Li, Peng, and Xu


China implemented Basel III in 2013 and tightened bank capital regulations. Empirical evidence shows that the new regulations significantly reduced bank risk-taking following monetary policy easing. To meet the tightened capital requirements, banks respond to a balance-sheet expansion by raising the share of lending to state-owned enterprises (SOEs) that are perceived as low-risk borrowers under government guarantees. We estimate that a one standard deviation positive shock to M2 growth raises the probability of SOE lending by up to 27%. Raising the share of SOE lending, however, reduces aggregate productivity, creating a trade-off between financial stability and allocative efficiency.

Robotic Labour: The Automation Channel of Pandemic-Induced Uncertainty

VoxEU, 2020 | with Leduc


The COVID-19 pandemic has raised concerns about the future of work. The pandemic may become recurrent and necessitate repeated adoptions of social distancing measures, creating substantial uncertainty about worker productivity. This column presents a theoretical framework suggesting that such job uncertainty reduces aggregate demand, and dampens business investment in general. However, automation may provide one way for businesses to cope with the uncertainty about worker productivity. It appears that pandemic-induced job uncertainty could stimulate automation investment, despite declines in aggregate demand.

The Weak Job Recovery in a Macro Model of Search and Recruiting Intensity

American Economic Journal: Macroeconomics 12(1), January 2020, 310-343 | with Leduc


We show that cyclical fluctuations in search intensity and recruiting
intensity are quantitatively important for explaining the weak job recovery
from the Great Recession. We demonstrate this result using an estimated
labor search model that features endogenous search and recruiting intensity.
Since the textbook model with free entry implies constant recruiting
intensity, we introduce a cost of vacancy creation, so that firms respond to
aggregate shocks by adjusting both vacancies and recruiting intensity.
Fluctuations in search and recruiting intensity driven by shocks to
productivity and the discount factor help bridge the gap between the actual
and model-predicted job filling rate.


wp2016-09_appendix.pdf – Supplemental appendix
Leduc-Liu-replication-files.zip – Replication files

Reserve Requirements and Optimal Chinese Stabilization Policy

Journal of Monetary Economics 103, May 2019, 33-51 | with Chang, Spiegel, and Zhang


We build a two-sector DSGE model to study reserve requirement adjustments, a frequently-used policy tool for macro-stabilization in China. State-owned enterprises
(SOEs) are financed by government-guaranteed bank loans, which are subject to reserve requirements, while private firms rely on unregulated off-balance sheet financing. Increasing reserve requirements reallocates resources to more productive private firms, raising aggregate
productivity, but also raises the incidence of SOE bankruptcy. Optimal reserve requirement adjustments are complementary to money supply adjustments for improving macroeconomic
stability and welfare. However, welfare gains are greater under sector-specific productivity shocks, which call for resource reallocation, than under aggregate productivity shocks.


wp2016-10_appendix.pdf – Supplemental Appendix
CLSZ_rep_code.zip – Replication code (zip)

Breaking the “Iron Rice Bowl:” Evidence of Precautionary Savings from the Chinese State-Owned Enterprises Reform

Journal of Monetary Economics 94, 2018, 94-113 | with He, Huang, and Zhu


China’s large-scale reform of state-owned enterprises (SOE) in the late 1990s provides a natural experiment for estimating precautionary savings. Before the reform, SOE workers enjoyed similar job security as government employees. The reform caused massive SOE layoffs, but government employees kept their “iron rice bowl.” The changes in the relative unemployment risks for SOE workers provide a clean identification of income uncertainty. With self-selection biases mitigated by focusing on government assigned jobs, precautionary savings account for about 40 percent of SOE households’ wealth accumulation. Moreover, demographic groups more vulnerable to the reform also accumulated more precautionary wealth.

Dollar Appreciation and Asian Economies

Vox China, 2017 | with Spiegel and Tai


The sharp appreciation of the U.S. dollar between mid-2014 and mid-2015 raised concerns in the U.S. and its major trading partners. Zheng Liu, Mark Spiegel, and Andrew Tai from the San Francisco Fed evaluate the impact of dollar appreciation on economic conditions in the United States and its three major Asian trading partners: South Korea, Japan, and China.

Measuring the Effects of Dollar Appreciation on Asia: A FAVAR Approach

Journal of International Money and Finance 74, June 2017, 353-370 | with Spiegel and Tai


Exchange rate shocks have mixed effects on economic activity in both theory and empirical
VAR models. In this paper, we extend the empirical literature by considering the implications
of a positive shock to the U.S. dollar in a factor-augmented vector autoregression
(FAVAR) model for the U.S. and three large Asian economies: Korea, Japan and China. The
FAVAR framework allows us to represent a country’s aggregate economic activity by a latent
factor, generated from a broad set of underlying observable economic indicators. To control
for global conditions, we also include in the FAVAR a ‘‘global conditions index,” which is
another latent factor generated from the economic indicators of major trading partners.
We find that a dollar appreciation shock reduces economic activity and inflation not only
for the U.S. economy, but also for all three Asian economies. This result, which is robust
to a number of alternative specifications, suggests that in spite of their disparate economic
structures and policy regimes, the dollar appreciation shock affects the Asian economies primarily through its impact on U.S. aggregate demand; and this demand channel dominates
the expenditure-switching channel that affects a country’s export competitiveness.

Uncertainty Shocks Are Aggregate Demand Shocks

Journal of Monetary Economics 82, September 2016, 20-35 | with Leduc


Search frictions in the labor market give rise to a new option-value channel through which uncertainty affects aggregate economic activity, and the effects of which are reinforced by the presence of nominal rigidities. With these features, an increase in uncertainty resembles an aggregate demand shock because it increases unemployment and lowers inflation. Using a new empirical measure of uncertainty based on the Michigan survey and a VAR model, we show that these theoretical patterns are consistent with US data. Using a calibrated DSGE model, we show that combining search frictions and nominal rigidities can match the qualitative VAR pattern and account for about 70 percent of the empirical increase in unemployment following an uncertainty shock.


wp12-10bk_appendix.pdf – Supplemental Appendix

Land Prices and Unemployment

Journal of Monetary Economics 80, June 2016, 86-105 | with Miao and Zha


We integrate the housing market and the labor market in a dynamic general equilibrium model with credit and search frictions. We argue that the labor channel, combined with the standard credit channel, provides a strong transmission mechanism that can deliver a potential solution to the Shimer (2005) puzzle. The model is confronted with U.S. macroeconomic time series. The estimation results account for two prominent facts observed in the data. First, land prices and unemployment move in opposite directions over the business cycle. Second, a shock that moves land prices also generates the observed large volatility of unemployment.

Capital Controls and Optimal Chinese Monetary Policy

Journal of Monetary Economics 74, September 2015, 1-15 | with Chang and Spiegel


China’s external policies, including capital controls, managed exchange rates, and sterilized interventions, constrain its monetary policy options for maintaining macro-
economic stability following external shocks. We study optimal monetary policy in a dynamic stochastic general equilibrium (DSGE) model that incorporates these “Chinese characteristics”. The model highlights a monetary policy tradeoff between domestic price stability and costly sterilization. The same DSGE framework allows us to evaluate the welfare implications of alternative liberalization policies. Capital account and exchange rate liberalization would have allowed the Chinese central bank to better stabilize the
external shocks experienced during the global financial crisis.


CLS_Erratum.pdf – Erratum
wp2012-13supplement_replication_files.zip – data for replication (276 kb)

Optimal Monetary Policy and Capital Account Restrictions in a Small Open Economy

IMF Economic Review 63, September 2015, 298-324 | with Spiegel


Declines in interest rates in advanced economies during the global financial crisis resulted in surges in capital flows to emerging market economies and triggered advocacy of capital control policies. The paper evaluates the effectiveness for macroeconomic stabilization and the welfare implications of the use of capital account policies in a monetary DSGE model of a small open economy. The model features incomplete markets, imperfect asset substitutability, and nominal rigidities. In this environment, policymakers can respond to fluctuations in capital flows through capital account policies such as sterilized interventions and taxing capital inflows, in addition to conventional monetary policy. The welfare analysis suggests that optimal sterilization and capital controls are complementary policies.

Temptation and Self-Control: Some Evidence and Applications

Journal of Money, Credit and Banking 47(4), June 2015, 581-615 | with Huang and Zhu


This paper studies the empirical relevance of temptation and self-control using household-level data from the Consumer Expenditure Survey. We construct an infinite-horizon consumption-savings model that allows, but does not require, temptation and self-control in preferences. In the presence of temptation, a wealth–consumption ratio, in addition to consumption growth, becomes a determinant of the asset-pricing kernel, and the importance of this additional pricing factor depends on the strength of temptation. To identify the presence of temptation, we exploit an implication of the theory that a more tempted individual should be more likely to hold commitment assets such as individual retirement account (IRA) or 401(k) accounts. Our estimation provides empirical support for temptation preferences. Based on our estimates, we explore some quantitative implications of this class of preferences for capital accumulation in a neoclassical growth model and the welfare cost of the business cycle.

Discussion of Notarpietro and Siviero

Journal of Money, Credit and Banking 47 (S1), April 2015, 411-417

Credit Constraints and Self-Fulfilling Business Cycles

American Economic Journal: Macroeconomics 6(1), January 2014, 32-69 | with Wang


We argue that credit constraints not only amplify fundamental shocks,
they can also lead to self-fulfilling business cycles. We study a model with heterogeneous firms, in which imperfect contract enforcement implies that productive firms face binding credit constraints, with the borrowing capacity limited by expected equity value. A drop in equity value tightens credit constraints and reallocates resources from productive to unproductive firms. Such reallocation reduces aggregate productivity, further depresses equity value, generating a financial multiplier. Aggregate dynamics are isomorphic to those in a representative-agent economy with increasing returns. For sufficiently tight credit constraints, the model generates self-fulfilling business cycles.

The Transmission of Productivity Shocks: What Do We Learn about DSGE Modeling?

Annales d’Economie et de Statistique (Annals of Economics and Statistics) 109/110, June 2013, 283-304 | with Phaneuf


Nominal rigidities are known to be important for the transmission of monetary policy. We argue that nominal rigidities are important also for the transmission of technology shocks, especially for explaining their effects on hours and real wages. Evidence suggests that a positive technology shock leads to a short-run decline in labor hours and a gradual rise in real wages. We examine the ability of an RBC model augmented with real frictions, a pure sticky-price model, a pure sticky-wage model, and a model combining sticky prices and sticky wages in accounting for this evidence. For each model, we examine the implications of the Frisch elasticity of hours and the extent of monetary policy accommodation for the results. We show that both sticky prices and sticky nominal wages are important for explaining the observed effects of technology shocks on labor market variables. This finding is robust and it holds with a small Frisch elasticity of hours and a relatively high frequency of price re-optimization that are consistent with microeconomic evidence

Land-Price Dynamics and Macroeconomic Fluctuations

Econometrica 81(3), May 2013, 1147-1184 | with Wang and Zha


We argue that positive co-movements between land prices and business investment
are a driving force behind the broad impact of land-price dynamics on the macroeconomy. We develop an economic mechanism that captures the co-movements by incorporating two key features into a DSGE model: We introduce land as a collateral asset in firms’ credit constraints, and we identify a shock that drives most of the observed fluctuations in land prices. Our estimates imply that these two features combine to generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through the joint dynamics of land prices and business investment.

Should the Central Bank Be Concerned about Housing Prices?

Macroeconomic Dynamics 17, January 2013, 29-53 | with Jeske


Housing is an important component of the consumption basket. Since both rental prices and goods prices are sticky, the literature suggests that optimal monetary policy should stabilize both types of prices, with the optimal weight on rental inflation proportional to the housing expenditure share. In a two-sector DSGE model with sticky rental prices and goods prices, however, we find that the optimal weight on rental inflation in the Taylor rule is small—much smaller than that implied by the housing expenditure share. We show that the asymmetry in policy responses to rent inflation versus goods inflation stems from the asymmetry in factor intensity between the two sectors.


wp10-05bk.pdf – Working paper version, FRBSF WP2010-05

Sources of Macroeconomic Fluctuations: A Regime-Switching DSGE Approach

Quantitative Economics 2(2), July 2011, 251-301 | with Waggoner and Zha


We examine the sources of macroeconomic fluctuations by estimating a variety of richly parameterized DSGE models within a unified framework that incorporates regime switching both in shock variances and in the inflation target. We propose an efficient methodology for estimating regime-switching DSGE models. Our counterfactual exercises show that changes in the inflation target are not the main driving force of high inflation in the 1970s. The model that best fits the U.S. time-series data is the one with synchronized shifts in shock variances across two regimes, and the fit does not rely on strong nominal rigidities. We provide evidence that a shock to the capital depreciation rate, which resembles a financial shock, plays a crucial role in accounting for macroeconomic fluctuations.


wp09-01bk.pdf – Working paper version, FRBSF WP2009-01

Asymmetric Expectation Effects of Regime Shifts in Monetary Policy

Review of Economic Dynamics 12(2), April 2009, 284-303 | with Waggoner and Zha


This paper addresses two substantive issues: (1) Does the magnitude of the expectation effect of regime switching in monetary policy depend on a particular policy regime? (2) Under which regime is the expectation effect quantitatively important? Using two canonical DSGE models, we show that there exists asymmetry in the expectation effect across regimes. The
expectation effect under the dovish policy regime is quantitatively more important than that under the hawkish regime. These results suggest that the possibility of regime shifts in monetary policy can have important effects on rational agents’ expectation formation and on equilibrium dynamics. They offer a theoretical explanation for the empirical possibility that a policy shift from the dovish regime to the hawkish regime may not
be the main source of substantial reductions in the volatilities
of inflation and output.

Learning, Adaptive Expectations, and Technology Shocks

The Economic Journal 119, March 2009, 377-405 | with Huang and Zha


This study explores the macroeconomic implications of adaptive expectations in a standard growth model. We show that the self-confirming equilibrium under adaptive expectations is the same as the steady-state rational expectations equilibrium for all admissible parameter values, but that dynamics around the steady state are substantially different between the two equilibria. The differences are driven mainly by the dampened wealth effect and the strengthened intertemporal substitution effect, not by escapes emphasized by Williams (2003).  Consequently, adaptive expectations can be an important source of frictions that amplify and propagate technology shocks and seem promising for generating plausible labor market dynamics.

Gains from International Monetary Policy Coordination: Does It Pay to Be Different?

Journal of Economic Dynamics and Control 32(7), July 2008, 2,085-2,117 | with Pappa


In a two country world where each country has a traded and a nontraded sector and each sector has sticky prices, optimal independent policy in general cannot replicate the natural-rate allocations. There are potential welfare gains from coordination since the planner under a cooperating regime internalizes a terms-of-trade externality that independent policymakers overlook. If the countries
have symmetric trading structures, however, the gains from coordination are quantitatively small. With asymmetric trading structures, the gains can be sizable since, in addition to internalizing the terms-of-trade externality, the planner optimally engineers a terms-of-trade bias that favors thecountry with a larger traded sector.

Investment-Specific Technological Change, Skill Accumulation, and Wage Inequality

Review of Economic Dynamics 11(2), April 2008, 314-334 | with He


Wage inequality between education groups in the United States has increased substantially since the early 1980s. The relative number of college-educated workers has also increased dramatically in the postwar period. This paper presents a unified framework where the dynamics of both skill accumulation and wage inequality arise as an equilibrium outcome driven by measured investment-specific technological change. Working through equipment-skill complementarity and endogenous skill accumulation, the model does well in capturing the steady growth in the relative quantity of skilled labor during the postwar period and the substantial rise in wage inequality after the early 1980s. Based on the calibrated model, we examine the quantitative effects of some hypothetical tax-policy reforms on skill accumulation, wage inequality, and welfare.

Technology Shocks and Labor Market Dynamics: Some Evidence and Theory

Journal of Monetary Economics 54(8), November 2007, 2,534-2,553 | with Phaneuf


A positive technology shock may lead to a rise or a fall in per capita hours, depending on how hours enter the empirical VAR model. We provide evidence that, independent of how hours enter the VAR, a positive technology shock leads to a weak response in nominal wage inflation, a modest decline in price inflation, and a modest rise in the real wage in the short run and a permanent rise in the long run. We then examine the ability of several competing theories to account for this VAR evidence. Our preferred model features sticky prices, sticky nominal wages, and habit formation. The same model also does well in accounting for the labor market evidence in the post-Volcker period.

Business Cycles with Staggered Prices and International Trade in Intermediate Inputs

Journal of Monetary Economics 54(4), May 2007, 1,271-1,289 | with Huang


International trade in intermediate inputs and, increasingly, in goods produced at multiple stages of processing has been widely studied in the real trade literature. We assess the role of this feature of modern world trade in accounting for some stylized facts about international business cycles. Our model with staggered prices and trade in intermediates across four stages of processing does well in explaining the observed international correlations in aggregate quantities, and it performs much better than a single-stage model with no trade in intermediates. The model in itself does not provide a full account of the cyclical behavior of the real exchange rate, but, compared to the single-stage model, it moves in the right direction.

Sellers’ Local Currency Pricing or Buyers’ Local Currency Pricing: Does It Matter for International Welfare Analysis?

Journal of Economic Dynamics and Control 30(7), July 2006, 1,183-1,213 | with Huang


We study international transmissions and welfare implications of monetary shocks in a two-country world with multiple stages of production and multiple border-crossings of intermediate goods. This empirically relevant feature is important, as it has opposite implications for two external spillover effects of a unilateral monetary expansion. If all production and trade are assumed to occur in a single stage, the conflict-of-interest terms-of-trade effect tends to dominate the common-interest efficiency-improvement effect for reasonable parameter values, so that the international welfare effects would depend in general on the underlying assumptions about the currencies of price setting. The stretch of production and trade across multiple stages of processing magnifies the efficiency-improvement effect and dampens the terms-of-trade effect. Thus, a monetary expansion can be mutually beneficial regardless of its source or the pricing assumptions.

Inflation Targeting: What Inflation Rate to Target?

Journal of Monetary Economics 52(8), November 2005, 1,435-1,462 | with Huang


In an economy with nominal rigidities in both an intermediate good sector and a finished good sector, and thus with a natural distinction between CPI and PPI inflation rates, a benevolent central bank faces a tradeoff between stabilizing the two measures of inflation, a final output gap and, unique to our model, a real marginal cost gap in the intermediate sector, so that optimal monetary policy is second-best. We discuss how to implement the optimal policy with minimal information requirement and evaluate the robustness of these simple rules when the central bank may not know the exact sources of shocks or nominal rigidities. A main finding is that a simple hybrid rule under which the short-term interest rate responds to CPI inflation and PPI inflation results in a welfare level close to the optimum, whereas policy rules that ignore PPI inflation or PPI sector shocks can result in significant welfare losses.

Does Trade Openness Matter for Aggregate Instability?

Journal of Economic Dynamics and Control 29(7), July 2005, 1,165-1,192 | with De Fiore


This paper presents a cash-in-advance model of a small open economy and shows that whether an inflation-targeting interest rate rule introduces aggregate instability depends in general on the degree of openness to international trade. This result emerges regardless of whether prices are sticky or flexible. In a closed economy, as the monetary authority responds to movements in inflation, the resulting changes in interest rates affect aggregate consumption through an intertemporal substitution effect and an inflation tax effect. In a small open economy, this policy also induces changes in the terms of trade, which, depending on the degree of openness, can generate counteracting effects on consumption. As a consequence, the implications of interest rate rules on macroeconomic stability in an open economy differ from those in a closed economy.

Why Does the Cyclical Behavior of Real Wages Change Over Time?

American Economic Review 94(4), September 2004, 836-856 | with Huang and Phaneuf


The cyclical behavior of real wages has evolved from mildly countercyclical during the interwar period to modestly procyclical in the postwar era. This paper presents a general equilibrium business-cycle model that helps explain the evolution. In the model, changes in the real wage cyclicality arise from interactions between nominal wage and price rigidities and an evolving input-output structure.

Input-Output Structure and Nominal Rigidity: The Persistence Problem Revisited

Macroeconomic Dynamics 8(2), April 2004, 188-206 | with Huang


This paper revisits an important issue concerning the persistent real effect of a shock to monetary policy. Although recent sentiment has shifted away from price stickiness toward wage stickiness in explaining persistence, the present paper shows that introducing an input output structure tends to make the former an equally important monetary transmission mechanism. Under staggered wage setting, the well-known relative-wage effect is the only source of endogenous sluggishness in wage, and thus price, adjustments, regardless of whether there is an intermediate input. Under staggered price setting, relative wages are constant, but the presence of an intermediate input creates a real-wage effect that prevents nominal wages from deviating too much from a sticky intermediate-input price. Meanwhile, stickiness in the intermediate-input price translates directly into sluggishness in marginal-cost movement. This reinforces the endogenous rigidity in the nominal wages and makes firms pricing decisions even more rigid. Thus, although it makes no difference in output dynamics under staggered wage setting, the input output structure improves the ability of staggered price setting in generating persistence. As a consequence, the conventional wisdom on the equivalence of price and wage staggering may continue to hold for some reasonable parameter values.

Staggered Price-Setting, Staggered Wage-Setting, and Business Cycle Persistence

Journal of Monetary Economics 49(2), March 2002, 405-433 | with Huang

Production Chains and General Equilibrium Aggregate Dynamics

Journal of Monetary Economics 48(2), October 2001, 437-462 | with Huang

Seasonal Cycles, Business Cycles, and Monetary Policy

Journal of Monetary Economics 46(2), October 2000, 441-464

FRBSF Publications
Are Markups Driving the Ups and Downs of Inflation?

Economic Letter 2024-12 | May 13, 2024 | with Leduc and Li

Global Supply Chain Pressures and U.S. Inflation

Economic Letter 2023-14 | June 20, 2023 | with Nguyen

Can Monetary Policy Tame Rent Inflation?

Economic Letter 2023-04 | February 13, 2023 | with Pepper

Do Households Expect Inflation When Commodities Surge?

Economic Letter 2021-19 | July 12, 2021 | with Glick, Kouchekinia, and Leduc

Fiscal Multiplier at the Zero Bound: Evidence from Japan

Economic Letter 2021-14 | May 24, 2021 | with Goode and Nguyen

Capital Flow Surges and Rising Income Inequality

Economic Letter 2021-09 | March 29, 2021 | with Diwan and Spiegel

The Uncertainty Channel of the Coronavirus

Economic Letter 2020-07 | March 30, 2020 | with Leduc

Is Job Automation Keeping Down Wages?

SF Fed Video | Feb 2020 | with Leduc

Are Workers Losing to Robots?

Economic Letter 2019-25 | September 26, 2019 | with Leduc

Is GDP Overstating Economic Activity?

Economic Letter 2018-14 | May 29, 2018 | with Spiegel and Tallman

Is Boomer Retirement Still Weighing Down U.S. Equity Markets?

SF Fed Blog | Mar 2018 | with Spiegel

Reserve Requirements as a Chinese Macro Policy Tool

Economic Letter 2017-15 | May 22, 2017 | with Spiegel

Slow Credit Recovery and Excess Returns on Capital

Economic Letter 2016-28 | September 26, 2016 | with Tai

Interview with John Williams about China’s Growth Prospects

FRBSF 2015 Annual Report | Feb 2016 | with Spiegel and Nechio

Is China’s Growth Miracle Over?

Economic Letter 2015-26 | August 10, 2015

Global Aging: More Headwinds for U.S. Stocks?

Economic Letter 2014-38 | December 22, 2014 | with Spiegel and Wang

Job Uncertainty and Chinese Household Savings

Economic Letter 2014-03 | February 3, 2014

Uncertainty and the Slow Labor Market Recovery

Economic Letter 2013-21 | July 22, 2013 | with Leduc

External Shocks and China’s Monetary Policy

Economic Letter 2012-36 | December 3, 2012 | with Spiegel

Uncertainty, Unemployment, and Inflation

Economic Letter 2012-28 | September 17, 2012 | with Leduc

Boomer Retirement: Headwinds for U.S. Equity Markets?

Economic Letter 2011-26 | August 22, 2011 | with Spiegel

Does Headline Inflation Converge to Core?

Economic Letter 2011-24 | August 1, 2011 | with Weidner

Inflation: Mind the Gap

Economic Letter 2010-02 | January 19, 2010 | with Rudebusch

Other Works